Dispositions

Words you may need to know (see Glossary):

Exchange

A disposition is the permanent withdrawal of property from use in
your trade or business or in the production of income. A withdrawal
can be made by sale, exchange, retirement, abandonment, involuntary
conversion, or destruction. You generally recognize gain or loss when
you sell property. However, nonrecognition rules may allow you to
postpone some gain. See Publication 544.

For information on dispositions from a general asset account, see
Dispositions and Conversions under General Asset
Accounts, later.

Early Dispositions

Words you may need to know (see Glossary):

Clean-fuel vehicle

Clean-fuel vehicle refueling property

Convention

Nonresidential real property

Placed in service

Recovery period

Residential rental property

If you dispose of your property before the end of its recovery
period, it is called an early disposition. If you dispose of property
depreciated under MACRS, you are allowed a depreciation deduction for
the year of disposition. Determine your depreciation deduction for the
year of disposition by using the convention (discussed earlier) used
when the property was placed in service.

Mid-Month Convention Used

If you dispose of residential rental or nonresidential real
property, you base your depreciation deduction for the year of
disposition on the number of months in the year of disposal that the
property was in service. Under the mid-month convention, you treat
property disposed of anytime during a month as disposed of in the
middle of that month. Count the month of disposition as half a month
of service.

You determine the depreciation to claim by determining the
depreciation for the year and then multiplying it by a fraction. The
numerator of the fraction is the number of months (including partial
months) in the year that the property is considered in service. The
denominator is 12.

Example.
On July 2, 1998, you purchased and placed in service residential
rental property. The property cost $100,000, not including the cost of
land. You file your tax return based on the calendar year. You used
Table A-6 to figure your MACRS depreciation for this property. You
sold the property on March 2, 2000.

A full year of depreciation for 2000 is $3,636. This is $100,000
multiplied by .03636 (the percentage for the seventh month of the
third recovery year) from Table A-6. You then apply the mid-month
convention for the 2 1/2 months of use in 2000. Multiply
$3,636 by 2.5 and divide by 12 to get your 2000 depreciation deduction
of $757.50.

Property placed in service in short tax year.
If you placed property in service in a short tax year, how you
figure depreciation in the year of disposal depends on whether you are
using the simplified method or the allocation method.

Simplified method.
If you are using the simplified method, you figure depreciation in
the year of disposal by figuring depreciation for an entire year and
then multiplying that amount by a fraction. The numerator of the
fraction is the number of months (including parts of months) the
property is in service in the year. The denominator is 12.

Allocation method.
If you are using the allocation method, you figure depreciation for
each recovery year that is included in the tax year. You multiply the
depreciation figured for each recovery year by a fraction. The
numerator of the fraction is the number of months (including parts of
months) the property was in service in the tax year. The denominator
is 12. If there is more than one recovery year in the tax year, you
add together the depreciation for each recovery year.

Half-Year Convention Used

For property for which you used a half-year convention, the
deduction for the year of disposition is half the depreciation
determined for the full year.

Property placed in service in full tax year and disposed of
in short tax year.
If you dispose of property in a short tax year, you must determine
the midpoint of the year. See Half-year convention,
earlier, under MACRS Deduction in Short Tax Year for
how to determine the midpoint of a short tax year applying the
half-year convention.

Property placed in service in a short tax year and disposed
of in a later short tax year.
If you dispose of property in a short tax year that you had placed
in service in an earlier short tax year, how you figure depreciation
in the year of disposal depends on whether you are using the
simplified method or the allocation method. First you must figure the
midpoint of the tax year of disposal. See Half-year convention,
earlier, under MACRS Deduction in Short Tax Year for
how to determine the midpoint of a short tax year applying the
half-year convention. See Simplified method or
Allocation method, earlier, for how to figure depreciation
for the tax year of disposal.

Mid-Quarter Convention Used

For property for which you used the mid-quarter convention, you
must first determine the depreciation for the full year. Then you
multiply the depreciation by the applicable percentage for the quarter
of the tax year you disposed of the property. The percentages to use
for each quarter of the tax year are shown in the following table.

Quarter

Percentage

First

12.5%

Second

37.5

Third

62.5

Fourth

87.5

Property placed in service in full tax year and disposed of
in short tax year.
If you dispose of property in a short tax year, you must determine
both the quarter in which you dispose of the property and the midpoint
of that quarter. See Mid-quarter convention, earlier, under
MACRS Deduction in Short Tax Year for how to determine the
midpoint of a quarter in a short tax year.

Property placed in service in a short tax year and disposed
of in a later short tax year.
If you dispose of property in a short tax year that you had placed
in service in an earlier short tax year, how you figure depreciation
in the year of disposal depends on whether you are using the
simplified method or the allocation method. First you must figure the
quarter in which you disposed of the property and the midpoint of that
quarter. See Mid-quarter convention, earlier, under
MACRS Deduction in Short Tax Year for how to determine the
midpoint of a quarter in a short tax year. See Simplified method
or Allocation method, earlier, for how to figure
depreciation for the tax year of disposal.

Example.
On December 2, 1998, you placed an item of 5-year property in
service in your business. The property cost $10,000 and you did not
claim a section 179 deduction. Your basis for the property is $10,000.
You must use the mid-quarter convention because this is the only item
of business property you placed in service in 1998 and it was placed
in service during the last 3 months of your tax year. Because your
property is in the 5-year property class, you used Table A-5 to figure
your depreciation deduction. Your deductions for 1998 and 1999 were
$500 (5% of $10,000) and $3,800 (38% of $10,000). If you dispose of
the property on April 6, 2000, figure your 2000 depreciation using the
mid-quarter convention. First figure the deduction for the full year,
which is $2,280 (22.8% of $10,000). Since April is in the second
quarter of the year, you multiply $2,280 by 37.5% to get your
depreciation deduction of $855 for 2000.

Depreciation Recapture

With the exception of gain on the disposition of residential rental
and nonresidential real property, all gain on the disposition of
property depreciated under MACRS is recaptured (included in income) as
ordinary income up to the amount of previously allowed depreciation
deducted for the property. Depreciation for this purpose includes any
section 179 deduction claimed on the property and any deduction
claimed for clean-fuel vehicles and clean-fuel vehicle refueling
property. There is no recapture for residential rental and
nonresidential real property. For more information on depreciation
recapture, see Publication 544.